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NFIP’s Failure Fuels New Risks

Revered economist Thomas Sowell once observed, “Some things are believed because they are demonstrably true, but many other things are believed simply because they have been asserted repeatedly, and repetition has been accepted as a substitute for evidence.”

Sowell’s thinking may have bearing on why taxpayers and property owners have lost hundreds of billions of dollars as Congress has attempted to manage America’s flood risk over the past 43 years. It may also explain why taxpayers and property owners will continue to lose hundreds of billions more, at least until the tragically inaccurate, but-oft repeated idea that flood insurance rates should be artificially low is replaced by what evidence-based science and common sense have revealed during the last decade.

Government-controlled programs operating in what would otherwise be the domain of private enterprise have repeatedly led to unintended market distortions and financial distress; the National Flood Insurance Program (NFIP) is a prime example. While Congress and federal administrative staff have known empirically for many years that the NFIP has, and continues to, encourage behaviors that produce upside-down outcomes on a massive scale, overcoming intrenched misperceptions has proven very difficult. Unless the NFIP raises their rates and begins giving refunds to folks who buy private market flood coverage prior to the last day of their NFIP coverage, we will continue to see varying tragic outcomes that could have easily been avoided.

Congressional hearings have illuminated numerous acute problems surrounding the NFIP, such as insolvency, contributing to increased risk of flooding across the country, and insufficient and inaccurate flood mapping, to mention just a few. During these hearings, those who testified, as well as members of Congress, identified a correlation between the NFIP’s problems and the artificially low rates they charge – a reality that would likely not be the case if the NFIP followed congressional directives to meaningfully raise rates at a reasonable pace annually. Ironically and perhaps predictably, the unintended negative outcomes generated by the NFIP continue to grow – now spreading to GSEs (government-sponsored enterprises) Fannie Mae and Freddie Mac. 

The Trouble With Fannie and Freddie

Though publicly traded companies, Fannie Mae and Freddie Mac operate under a congressional charter that provides a financial backstop from the government – one that was invoked during the financial crisis of 2008 to the tune of $187 billion, according to The Shadow Open Market Committee. Fannie Mae and Freddie Mac were designed by Congress to expand the secondary market for mortgage debt and ultimately boost homeownership among buyers from a variety of demographics. While the GSEs have succeeded in boosting homeownership, they’ve been allowed by Congress to become “too big to fail.”

A recent article in POLITICO noted that Fannie Mae and Freddie Mac hold more than 60% of the mortgages in flood-prone areas across the U.S. Because these homes are technically located outside NFIP-designated “special flood hazard areas”  but inside the actual “100-year flood plain,”  these homeowners are not required by their lenders to purchase flood insurance. As a result, Fannie Mae and Freddie Mac are exposed to potentially existential risk from the peril of flood. Only owners of properties that are within an NFIP flood zone are required to buy flood insurance. That said, their equally flood-exposed neighbors are not forced to buy flood insurance, and as a result do not.

If a significant number of these uninsured, flood-exposed homes were to be seriously damaged by a flood, the owners might not have the resources to repair their homes and may have no incentive to do so if the cost of repairs is equal to or greater than the equity they have in the home. If climate change translates to more frequent or more severe floods, the implications for Fannie and Freddie are ominous.

In their article, POLITICO observes that taxpayers could be on the hook for more than $1 trillion in home mortgages as Fannie and Freddie fail to consider climate risk when purchasing mortgages from lenders. This practice could lead the country into recession even in the absence of a crescendo of floods. More and more savvy homebuyers and lenders are now using new technology to assess the climate risk on properties before they buy a home or originate a loan. This may translate to a downward spiral in flood-prone property values across broad sections of the country. Additionally, Fannie and Freddie may see an even greater concentration of flood-prone mortgages within their portfolios.

Reforming the NFIP will be both a political and a public policy problem until the practice of offering artificially low flood insurance premiums to some and overcharging others, as well as denying policyholders the option to easily switch to competing products, is discontinued. 

See also: Insurance Outlook for 2021

Reworking the NFIP

Congress created the NFIP as a way to shift the U.S. flood insurance market to private insurers. Unfortunately, in 1978, regulators used a loophole in the law that enabled them to remove private flood insurers from the market. This was not the original intent of Congress nor the desire of private flood insurers. Operating as what is essentially a nationalized flood insurance system, the NFIP has cost taxpayers about $1 billion per year since its inception.

What if the private market had continued to be involved in the nation’s flood insurance paradigm? I would venture to say that pricing would have at least kept up with losses. Likely, prices would have been high enough to discourage rampant building in dangerous locations. As a result, more coastal and riverine land would have been left to nature and thereby would have served to reduce the severity of flood events. And importantly, with fewer houses built in hazardous locations, we would have avoided the present-day financial risk to our nation’s economy faced by Fannie and Freddie.

When it comes to responding appropriately to climate risk, the NFIP experience has demonstrated that a government-controlled system is the wrong approach. The NFIP is now a political football, used as a favor for folks located close to sources of flooding at the expense of those located in less-flood-prone areas. This kind of unintended outcome is what often happens when the government takes over where the free market was willing to participate. Now, we are seeing manifold pernicious effects manifesting themselves in the mortgage finance market with staggering implications. 

Congress must focus on reforms that allow buyers to change flood insurance carriers at the time of their choosing and encourage the private sector to assume flood risk over the long term by assuring that the NFIP does as Congress has already instructed them to do – to raise rates to actuarially sound levels and serve as the flood insurer of last resort.

How Tech Improves Flood Modeling

Flood is a complex natural catastrophe, with great variations across small spatial areas, producing extremely localized effects. Sometimes, one property may be badly flooded while its neighbor two doors down is spared. As a result, managing flood risk is often seen as a challenge by U.S. insurers. In fact, although 90% of all natural disasters in the U.S. involve flooding, according to the Insurance Information Institute, it could still be regarded as the least understood natural peril.

Until recently, the complexities of flood behavior have been too intricate to fully represent using broad-scale modeling techniques. Likewise, flood data in the U.S. was not detailed enough to enable insurers to see the full picture of the hazard. Flood data has many other pitfalls, from being badly out of date to not providing full details on the different types and severities of flooding.

However, through continued advances in technology and data availability, we’re now able to achieve a more detailed analysis. Technology is rapidly progressing, and it’s incredible to think how much more we can achieve now than we could just a couple of decades ago.

Lessons from Donkey Kong: Using technology from the computer gaming industry

A key part of the flood mapping process is hydraulic modeling, and at JBA we run our hydraulic models using technology that was primarily developed for the computer gaming industry. You only have to consider how far the video game industry has come, from Donkey Kong to Fortnite, to understand advances that hydraulic models have experienced.

See also: It’s Time to Rethink Flood Coverage  

Donkey Kong was released as an arcade game in the early 1980s and was a breakthrough. However, the difference in resolution between the 1980s Donkey Kong and today’s version is striking.

©Copyright Nintendo

Our hydraulic models, which run on very similar technology, are now also much more sophisticated, and the resulting flood maps are more detailed and informative than ever.

Artificial intelligence (AI) and satellite data

We have also seen advances in artificial intelligence (AI) and machine learning, which fill knowledge gaps in our input data, as well as satellite technology, enabling us to access better data on elevation, land use and rivers. For example, we’ve trained machines to analyze elevation data to locate all the levees in the U.S. We are using similar algorithms to check the hydraulic model outputs for unusual patterns, which might indicate quality issues that we can then address much more quickly and effectively than before.

See also: Here Is How to Make Flood Insurance Work  

Over recent years, satellite technology and other techniques have improved, which means the quantity and quality of data on land use, rivers and rainfall, as well as on elevation, have increased significantly. We’ve progressed from using contour lines on maps to having light detection and ranging (LIDAR) data to sub-centimeter accuracy to describe the topography of an area.

As a result, we can achieve a lot more detail in flood mapping. This can help insurers to better understand flood risk in the U.S. and allow them to capitalize on latent opportunities in the private flood insurance market.

Top 5 Risks in Specialty Insurance

To help brokers better understand the current risks in specialty insurance and assist their clients, our team at Aon Programs, which serves independent insurance brokers across the U.S. with access to a portfolio of hundreds of specialized insurance programs, identified the top five areas of risk to watch out for.


Flood Risk: Apathy

Too many property owners today are blissfully ignorant to the flood risk they face. Even after the 2017 season, which saw Hurricanes Harvey, Irma and Marie cause billions of dollars of damage to the Southeastern seaboard, the public still struggles to see the value of flood insurance.

During a 30-year mortgage, a property owner is 27 times more likely to experience a flood than a fire, yet only 20% of the damage caused by Harvey was insured by flood insurance. Conversely, 90% of damage caused by the 2017 wildfires in northern California was covered by fire insurance.

After a hurricane season, people tend to think, “It was bad, but we’ll get past this. It won’t happen again.” This is the root of the struggle people have with flood insurance. They get comfortable, and they don’t think ahead, especially while the sun is shining.

Take Florida. While the Sunshine State has a higher ratio of property owners carrying flood insurance than the rest of the nation, inland cities such as Orlando have lower ratios of insured property owners. Most of these homes are outside the 100-year flood plain, and homeowners aren’t required by their mortgage company to buy flood insurance.

FEMA is remapping flood zones in much of the country. For example, Broward County is a coastal area, yet thousands of properties have been moved from A to X-zone, which sends the message that homeowners don’t need flood insurance. Brokers will play a critical role in advising clients to retain coverage.

See also: Protecting Airports From Flood Risk  

Fine Art Risk: Catastrophes

Coupled with the onslaught of wind and flood damage associated with hurricanes Harvey, Irma and Maria, the catastrophic Californian wildfires and mudslides in 2017 were truly alarming from both a personal and insurance industry perspective. In the past, there would be a lull between events, as was the case between Katrina in 2005 and Sandy in 2012. Now, weather-related severity and frequency dynamics are increasing as we face multiple, successive catastrophes in a single year.

Generally, when something gets wet or blown over it can be conserved. But, when it’s incinerated there’s no possibility of restoration, as was the case with the wildfires in California. Many homes, including those in luxurious neighborhoods, were burned to the ground, and the damage caused to art collections was devastating. For instance, one prominent private collector had his home completely burn to the ground. Nearly $10 million worth of artwork went up in smoke. For that particular family the loss was as emotional as much as it was physical – sadly, for the country, an important part of our collective cultural fabric was lost.

Meanwhile, we had another prominent collector with a waterfront home in Palm Beach that experienced hundreds of thousands of dollars of damage from Irma. Given the massive aggregation of wealth in that county, the insurance industry is fortunate that the hurricane tracked west.

Most individuals chose not to carry standalone flood insurance. Fortunately, specialty fine art insurance policies typically do not exclude the peril of flood, so it’s definitely in the financial interest of wealthy individuals with art collections to obtain this essential protection, particularly because homeowners’ policies exclude flood coverage.

Home Health Risk: Malpractice

With the aging of the baby boomer generation has come rapid growth in the home healthcare market. People today do not want to live in nursing homes. They prefer to remain in their residence, where they’re more comfortable living independently and costs are lower.

To meet this demand, home healthcare agencies provide skilled and unskilled services. In addition to nursing care, they provide non-medical custodial care with home health aides and companions who support activities of daily living including: cooking, cleaning and assistance driving patients to appointments. Unfortunately, with the high number of residents needing home healthcare, these agencies are having a hard time keeping up with the demand.

With the overburdening of home care agencies comes malpractice claims. Recently a home health aide took an elderly client shopping— and lost her in the mall. The woman was found the next day outside, having died from exposure to the elements. The result was a malpractice lawsuit that settled close to policy limits.

Common malpractice claims involve helping patients with the support of daily activities, like bathing. Lifting patients adds to the exposure. Brokers should be aware of their home health clients’ exposures, including professional liability and hired/non-owned auto to ensure they have the proper coverage in place.

Special Events Risk: Bodily Injury

Special events cover a wide variety of potential exposures, from a one-day fair at a local church to a week-long art festival at a university, to a musical concert that travels across the country for a year. The venues for each will require your client to provide a certificate of insurance showing general liability coverage.

One of the most common bodily claims we see arises from the use of golf carts. Organizers will use golf carts to run entertainers or staff members from spot to spot on the event grounds. Recently, we settled a claim that exceeded $500,000 at a large fairground where an employee who was headed to the parking lot offered an elderly woman a ride. He made a sharp turn, causing the woman to fall from the cart and suffer a head injury.

If someone were to walk into your office with a special event, you might be intimidated when looking at the venue contracts, especially if the event involves fireworks or liquor liability.

Nonprofit Risk: Cybercrime Notification

Cyber is a top concern for organizations in a multitude of industries, including nonprofits. It is imperative that nonprofits be aware of their own specific cyber situation, especially any geographic-specific legislation with which they need to comply. For example, a primary concern in Florida is the privacy data breach statute, known as the Florida Information Protection Act. The provisions of the law are not very well known in the insurance community, particularly when insuring community associations.

See also: Don’t Risk a Lot for a Little  

Here are the primary provisions of the statute:

  • Any commercial or governmental entity that stores personal information is subject to the law
  • The entity is responsible for taking reasonable measures to protect the data in its care, such as names, email addresses and Social Security numbers
  • Persons affected by a breach must be notified within 30 days from the time it is discovered
  • Violations are subject to a $1,000-a-day fine up to 30 days, and $50,000 fine for each subsequent 30-day period, not to exceed $500,000

Most cyber liability policies will provide some assistance complying with Florida’s notification requirements. The challenge is that there is no standardization within the industry. Many liability policies offer as little as a $25,000 or $50,000 cyber sublimit.

It is important for brokers to make sure their client is receiving coverage for first-party and third-party claims. The IHG D&O policy for community associations provides coverage up to the full limits of the policy for third-party liability claims and $100,000 for first-party expenses such as notification costs.

Staying abreast of emerging risks in the specialty insurance marketplace can help brokers recommend the appropriate coverage to their clients, and minimize their chances of experiencing an errors and omissions claim.

Protecting Airports From Flood Risk

Major storms, including accompanying winds and floods, threaten lives, destroy property and damage critical infrastructure. Power outages, broken communication lines and disruption to road, rail, sea and air transport are common in the aftermath of major storms.

Among the damages from September’s Hurricane Florence, for example, was the closure of 200 roads in South Carolina, including a section of Interstate 95 – a major highway connecting the U.S.’s East Coast. South Carolina officials estimated that the storm caused more than $300 million in infrastructure damage. On the other side of the globe, Typhoon Jebi caused widespread damage throughout Japan, and flooding closed an airport.

As storms and rising sea levels increase flood risk, governments around the world are looking for ways to better protect people and communities. In addition to devastating societies, over the past few decades floods have led to $550 billion in global economic impact. While we cannot fully protect ourselves from flood, working across industries is critical to build resilient communities and protect critical infrastructure.

With many of the world’s busiest airports at a low elevation – and many more built near water on reclaimed land – these hubs are prime examples of infrastructure in need of protection. Not surprisingly, airport operators are rising to the challenge.

In Depth

September’s Typhoon Jebi shut down Kansai International Airport in Japan’s Osaka Bay. The airport, built on a manmade island and handling almost 30 million passengers a year, suffered considerable damage. A storm surge breached a seawall and flooded a runway and terminal building, leaving thousands of passengers and staff stranded.

Kansai, a major international hub that serves several cities (including Kobe, Kyoto and Osaka), was closed for 10 days; and it took a further week to restore regular operations. Complicating the situation was the fact that critical facilities, such as the disaster response center and an electrical substation, were located in a terminal basement and flooded.

See also: Flood Risk: Question Is Where, Not When

Airports are critical elements of our infrastructure and, consequently, their resilience is essential. As the Airports Council International (ACI) noted in a September policy brief focused on airports’ resilience and their adaptation to climate change, “As an essential service provider to a wide range of stakeholders and users, the airport infrastructure and operations must have high levels of availability, reliability and resilience.”

Reclaimed Land, Rising Seas, Sinking Airports

Kansai is not the only major airport built on reclaimed land. Australia’s Brisbane Airport is on coastal reclaimed land, and San Francisco International Airport’s reclaimed site is gradually sinking.

Other airports are at risk simply because their low elevation puts them at risk of a storm surge. A recent report from the U.S. National Climate Assessment identified 13 of the country’s 47 busiest airports as having at least one runway within 12 feet of current sea levels. If sea levels continue to rise, these hubs will face increased exposure to storm surge risk.

In general, the hydrological importance of airports: runways, halls and other facilities create large areas of impermeable surface with zero infiltration capacity. During extremely intensive rainfalls, which are increasing in strength due to climate change, airports can become extremely prone to pluvial, or flash, flooding. This can add to the pressure on airport management to revisit how effective their flood protection really is, especially as some structures are decades old.

Addressing the Risks and Protecting Critical Assets

As structures face risks posed by severe weather and other potential shocks, protecting infrastructure means developing resilience.

Greg Lowe, global head, sustainability and resilience, at Aon, underscores the importance of properly safeguarding these critical assets – especially in the context of climate-related risk. Looking at infrastructure long-term, he states, is crucial, and “cities are asking whether their infrastructure is fit for purpose over decades.”

In the case of airports, the ACI’s September 2018 policy brief warned that more extreme weather “may lead to fundamental transformation of the socio-economic system.” For airports, “the risks of flooding, flight disruptions and cancellations become more likely.”

“Airports need to understand the risks and initiate adaptation measures for both existing and new infrastructure, as well as managing critical operations to become more resilient to the changing climate,” according to the ACI brief.

The ACI brief also encourages airport operators to examine all the potential impacts of extreme weather on their facilities so they can prioritize and respond to the risks. “Only comprehensive climate-change risk-management strategies will ensure the continuity of operation, profitability and asset value,” the brief said.

Gary Moran, head of aviation Asia at Aon, echoes the ACI’s advice and thinks many airport operators are taking it to heart. “We are seeing more consideration to protect against flood damage and planning around storm drains around airports so that they are fit for purpose.”

How Airports Are Increasing Resilience

As the exposures worsen, various airports are addressing their flood risks. San Francisco airport officials have installed seawalls and are looking to take other steps to protect the airport, including a potential $383 million project that would include measures to help the facility defend itself against further rises in sea level by 2025.

See also: Top Emerging Risks for Insurers  

Boston’s Logan International Airport has set a goal of becoming a national model for resilience planning and implementation among port authorities. Risk mitigation steps undertaken so far include purchasing temporary flood barriers, raising electrical and mechanical equipment above forecasted flood levels, sealing and waterproofing openings and conduits, installing water sensors and pumps and installing systems to anchor temporary flood fences and flood barriers in emergencies.

Meanwhile, Changi Airport in Singapore has resurfaced its runways to provide better drainage and is building a terminal at a higher level to protect against flooding as sea levels rise.

Brisbane Airport officials also are building higher, with a new runway built a meter higher than originally planned. Meanwhile a higher seawall and better drainage to address higher sea levels are also being planned.

Building Storm Resilience

Airports are a critical part of our modern infrastructure, essential to linking people and businesses around the world. Events that disrupt activities at a major airport can have a significant economic impact.

As low-lying airports recognize the risks associated with climate change and rising sea levels, it is critical that they begin to build resilience to storm surges and flooding. As they do so, they may well provide lessons to officials elsewhere who are looking to protect other forms of vital infrastructure from storms and other natural perils.

This article originally appeared on Aon’s The One Brief.

True Flood Risk’s Shelly Klose

Shelly Klose, Founder and CEO of True Flood Risk, describes how the company enhancing flood risk assessment and underwriting by enabling users to more precisely analyze property elevation and vulnerability to flood risk, access National Flood Insurance Program premiums and connect with agents and brokers to secure coverage.

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